Understanding and Utilizing Smart Contracts

One of the most significant growth sectors in blockchain over the last two years has been decentralized finance. This growth has shown investors different options besides getting sub-par returns from traditional finance and allowing your money to work for you through lending. The usual outcome of these scenarios is with greater reward comes more risk. Still, the value in this particular situation comes from a lack of participants as the barrier of entry is high due to technical know-how.

We have covered aspects of these smart contracts by discussing how you can lend your digital currencies with Compound and other platforms, but understanding these contracts at a fundamental level is essential for proper utilization. It can help protect you from possible loss of funds.

What is it?

A smart contract is an agreement between two people in the form of computer code. The code is stored on a public blockchain and cannot be changed. The transactions contained within the smart contract are processed by the blockchain, which means smart contracts can send them automatically without a trusted third party.

These contracts can operate within its’ given parameters, but one issue we have seen is poorly written code resulting in loss of funds or easily exploited by financially motivated attackers. The lack of third-party trust relies on the executable code being flawless, which usually takes multiple iterations to reach. The newer the project is more likely for coding errors, but these errors are tested and updated over time.

With traditional databases, upgrading is as easy as deploying the new code, but with blockchain ledgers, an upgraded smart contract requires complete redeployment. The immutability makes smart contracts more like hardware development instead of software as they cannot be changed in the event of found exploits and instead must be taken down or frozen. Unfortunately, this has happened before, causing losses of millions of dollars, such as the DAO hack we discussed last week.

Staying Safe

Thoroughly reviewing new projects or looking for professionally audited contracts to interact with can help protect you from what is referred to in the crypto ecosystem as a rug pull.

A rug pull consists of developers creating a contract to exploit users or abscond with funds. While this problem is severe and frequently happens in the unregulated space, Contracts are visible to everyone. This takes expertise to audit currently, but these barriers become easier to navigate over time and allow for more ready adoption.

Finding projects earlier, without audited code, can sometimes produce exponential gains and pose the risk of disaster. Projects like YAM finance were able to accrue 500 million in assets within days of launch with unaudited code, leading to a 750 thousand dollar loss of funds.

Platforms need months to execute real-world transactions outside of the test-net environment before I would consider investing.

Future of Smart Contracts

This subject is gaining more traction in the current US law system as of late due to the massive growth over the last year. While we have not seen any traditional courtrooms pass judgment on smart contracts, OpenLaw founder Aaron Wright believes past contract law will uphold the current iterations of smart contract functions. One platform looking to upgrade smart contract deployment is Tezos. The consensus and governance system on Tezos allows for upgrades to deploy after consensus is reached, permitting faster upgrades to the codebase. As with everything in blockchain development, the landscape will change dramatically within a few years, and these early iterations will lay the foundation for finance.